In the Financial Post series on alternative investing, David Kaufman, president of Westcourt Capital Corp., takes investors beyond traditional stocks and bonds to explore how to add value to your portfolio with hedge funds, debt instruments, real estate investment trusts, mortgage funds, private equity and even collections of art and wine. The series will run Wednesdays and Fridays.

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In the wake of the recent financial crisis, investors are hungry for investments that provide a steady, meaningful yield while minimizing the risk of wild fluctuations in the value of their invested capital. Real estate has been a mainstay of income-seeking investors for hundreds of years, and real estate investment trusts, or REITs, are an excellent option for this class of investment.

REITs are investment funds that pool investors’ capital, deploying it (along with borrowed capital to provide levered returns) in the purchase of income-producing real estate ranging from office towers to commercial properties to residential apartment complexes.

REIT unitholders benefit from a diversification in assets that would be impossible to achieve were they investing individually. Once the assets are purchased, the rent collected from their operation (less management fees in the range of 2%-3%) is passed through to investors, generally yielding between 7-9% per annum.

In addition to benefiting from the ownership of diversified assets, REIT unitholders also enjoy distributions that tend to be very tax-efficient. Because of the way in which real estate assets are depreciated, much of the returns to investors (whether taken in cash or re-invested into the REIT) are designated as “return of capital,” deferring most of the income tax that would otherwise be payable in the year in which the distributions were received, but having the effect of lowering investors’ cost base.

Canadian REITs can be publicly traded or available by private placement to “qualified investors” (generally high-net worth individuals). Public REITs have the upside of providing virtually instant liquidity to investors, who buy and sell them much the way they would mutual fund units.

In recent years, however, public REITs have demonstrated positive correlation to the public equity markets, meaning that their unit value has risen and fallen along with the stock market. For investors seeking a conservative, income-producing investment, these fluctuations in value have been hard to stomach.

Private REITs provide similar annual distributions to public REITs but little volatility in unit value. The downside of private REITs is illiquidity: investors are generally “locked in” for at least a year and redemptions following the first year may be subject to redemption penalties. Although the illiquidity can be off-putting during the due diligence process, consider that individual real estate investments are designed to be long-term, which is how pooled real estate investments ought to be viewed as well.

REIT investors must also understand that, although the primary objective of their investment is to achieve attractive yields with moderate capital appreciation, they are investing in real estate as equity participants, employing leverage to do so. This means that poorly managed REITs (just as any poorly managed pooled investment fund) can put investors’ capital at risk. Before filling out a subscription agreement, therefore, familiarize yourself with the REIT’s operating procedures, fund manager and long-term performance record.

David Kaufman is the president of Westcourt Capital Corporation, an Exempt Market Dealer specializing in conservative, alternative income-generating investments. drk@westcourtcapital.com